Stopping
Goods in Transit and
Reclamation Demands Under Check 21Does the Vendor Now Have Greater Protection When Accepting Payment by Check?

You conclude that a new customer is too risky to extend terms,
so you insist on COD. You authorize shipment on the condition that
your delivery driver picks up the check from your customer. The
goods are delivered, but several days later the check is returned �NSF.� You
immediately contact your shipper to stop further deliveries to
the debtor, and return any product in transit to your warehouse.
You also make a reclamation demand for the goods the debtor recently
received.

Unfortunately, the shipper reports that it cannot honor the stop
shipment demand as the goods had already been delivered to the
debtor. Further, the debtor responds to the reclamation demand
by advising that your goods have already been used in the ordinary
course of its operations. You rightfully complain that that had
you received prompt notice of the �NSF� you could have stopped
some shipments reaching the debtor, and perhaps reclaimed that
product that reached the debtor.

A new law may be better protect vendors from the too common situation
above. On October 28, 2004, a federal law accelerating check processing,
known as Check 21, went into effect (the official name, Check Clearing
for the 21st Century Act). This is federal legislation affecting
all states. Check 21 changes the way that checks are processed
in the United States, as well as the technology of check payment
and acceptance. Under Check 21, financial institutions are allowed
to process checks electronically, instead of transporting the paper.

What is the impact of Check 21 and a vendor�s right to stop goods
in transit, as well as return goods based on a reclamation demand?
Does check 21�s �farewell to the float� mean greater protections
for the vendor unwittingly accepting payment by check from an insolvent
customer?

A. Stopping Goods in Transit

Article 2 of the Uniform Commercial Code deals with the rights
of a vendor to stop goods in transit where the goods are in the
hands of other bailees, such as a carrier or warehouseman. However,
once the goods have been received by the buyer, the right of stoppage
is lost.

The vendor may stop goods where the buyer breaches the contract
or fails to make payment when due. The vendor gives notice of stopping
goods to the buyer with a stop order or stop notice. The notice
should be given to the carrier or bailee. Under the UCC, the vendor�s
right to stoppage is lost upon the buyer�s receipt of goods. Receipt
is defined under the UCC as physical possession. Stoppage of goods
does not consider when title passes.

Courts generally recognize the right of the vendor to stop goods
in transit after the buyer has filed bankruptcy. However, the vendor
should seek relief from the automatic stay prior to selling the
goods. Stopping goods in transit should not be considered a preference,
as the buyer did not have an interest in the goods.

The remedy of stopping goods in transit is a time-of-the-essence
remedy for the vendor. The vendor must promptly notify the carrier
upon learning of the NSF check. Check 21 may better protect the
vendor�s stoppage rights, as the vendor may be immediately notified
by its bank of the NSF, which may permit the vendor to stop the
goods that are in transit.

B. Reclamation

Article 2 of the Uniform Commercial Code provides a vendor selling
goods on COD the right to reclaim goods when the customer�s check
is returned NSF. Bankruptcy Code section 546(c) recognizes a vendor�s
reclamation right where the customer is in bankruptcy and the cash
sale was in the ordinary course of business.

A vendor selling goods on cash shortly before the customer�s bankruptcy
may find the check returned NSF, even with Check 21�s accelerated
clearing. The vendor should assume that the customer�s check will
be returned NSF and send its reclamation demand immediately upon
learning of the customer�s bankruptcy filing.

With Check 21, perhaps the check will clear prior to the customer�s
bankruptcy filing; however, the reclamation demand may protect
the vendor from the risk that the time periods for making a reclamation
demand would run out prior to the vendor�s receipt of confirmation
that the customer�s check had been dishonored. Again, due to Check
21, the vendor should receive prompt notification that the check
has been dishonored.

Courts have settled upon the following elements to establish a
valid reclamation claim under the Bankruptcy Code:

(i) the vendor sold goods on credit to the debtor in the ordinary
course of business of both;

(ii) the vendor delivered the goods to the debtor at a time
when the debtor was insolvent;

(iii) the vendor made a written demand for the return of the
goods within ten, or in certain cases twenty, days after the
goods were delivered to the debtor; and

(iv) the debtor had possession of the goods at the time of the
reclamation demand or the goods were not in the hands of a buyer
in the ordinary course or a good faith purchaser at the time
of demand.

A vendor initiates reclamation by delivering a reclamation letter
(see letter attached) within ten days, or in certain cases twenty
days, after the goods were delivered. The reclamation letter should
include a detailed description of the goods in question, a statement
of the delivery date to the debtor, and a demand for the immediate
return of the goods. The reclamation letter should also demand
an accounting. An accounting is crucial, because the right to reclaim
may be defeated by the debtor�s resale of the goods to a buyer
in the ordinary course of business.

If the accounting is not delivered or not accurate, the vendor
should be prepared to immediately demand a right to inspect both
the inventory on hand and the books and records pertaining to sales
of said goods for the period between the date of delivery of the
goods and the date of the reclamation letter.

If the buyer files bankruptcy prior to making the reclamation
demand (or at any time thereafter) the vendor should promptly contact
debtor�s counsel in order to stipulate with the debtor for the
immediate return of the goods or for the debtor to sell the goods,
provided the vendor is granted an administrative claim or a lien
under the Bankruptcy Code.

If there are no bankruptcy proceedings, the vendor must initiate
legal action in state court pursuant to the UCC. The vendor should
bring a complaint for replevin and a writ of attachment against
the proceeds of any sale of goods protected by the reclamation
demand.

A vendor has the burden to establish that the debtor was insolvent
at the time the debtor received the goods. Courts strictly enforce
the requirement that the goods be in the possession of the debtor
when reclamation is demanded. If the debtor has transferred the
goods to a good faith purchaser before the reclamation demand is
made, the reclaiming vendor loses all reclamation rights to the
goods. As a result of Check 21, the vendor may more easily establish
this element as the vendor may be able to make a more timely reclamation
demand, given the prompt notice under chapter 21 of the NSF check.

Some courts have determined that a secured creditors right will
extinguish all of the reclaiming vendor�s rights. Therefore, only
those goods that were sold to the debtor prior to the filing were
subject to any security interest.

Although difficult to get, the vendor should insist upon a lien
on the assets of the bankruptcy estate, rather than an administrative
claim. An administrative claim will not get satisfied if the bankruptcy
case is administratively insolvent. A vendor�s lien under the Bankruptcy
Code is measured by the price realized by the debtor for the goods
sold. As such, an agreement as to the amount of the lien or claim
is advisable, so as to avoid recovering less than the resale price
of the goods.

Like a vendor�s stoppage rights, Check 21 should aid the vendor
making a reclamation demand as the vendor should learn earlier
of the NSF and, therefore, make a more prompt reclamation demand.

C. Overview Of Check 21

Approximately 75 percent of trade credit transactions are conducted
by check. Check 21 focuses on the delay caused by a paper check
being transported through the banking system.

Check 21 permits the depository bank, if it so chooses, to �truncate� the
original check. Truncating a check means to take the check out
of physical circulation by transforming it using a computer scanner
into a digital image, also known as a substitute check. This digital
image becomes the legal equivalent of the original check, provided
it meets the criteria set out in the legislation. Truncating the
check permits banks to process the digital image for payment in
hours rather than days. As a result of image technology, check
delays attributable to weather or air travel are gone.

D. Check 21 Makes the Remedies of Stopping Goods in Transit and
Reclamation More Valuable

Check 21 better protects vendors from the risks of an NSF check,
especially the typically lengthy time it takes to learn that the
check does not clear, especially an outof- state check has not
cleared. As a result of image technology, vendors will receive
notice of the NSF check and can take steps to protect the sale,
including a more timely demand to stop goods in transit or reclamation
demand.